Human Capital Contracts for Asia

During the last summer I conducted research on the viability of the implementation of Human Capital Contracts in a developing country. As I am Colombian and was familiar with the information available, the obvious start was to focus on my country. However, as I have been living in Asia and have been in contact with developing countries in this part of the world, I would like to develop a similar analysis here. In this article, I try to explain to Asian readers what Human Capital Contracts are; maybe some readers will want to follow me or join in the research presented here.

Governments in developing countries have to deal with tight budget restrictions, which lead to under-investment in education. Great efforts and advances have been made in the coverage of basic education, but this is not necessarily the case in higher education. In developing countries, individuals with a great potential might be left out of the higher education system because they do not have the financial means to access it and the Government does not have the means to assist the increasing demand either. Then, individuals with no access to education lose the opportunity to develop their full potential and the society loses the gains in productivity and welfare which are derived from education. Under this reality, any attempt to improve the access to education can improve the current situation.

In Asia, demand for higher education has exploded. According to John Hawkins and Victor Ordoñez (2007) , enrolment in Asia has increased from 13 million people in the 60s, to more than 80 million in 1995, and up to 300 million by 2006. This jump comes mainly from East and South Asia, where individuals with higher education degrees have multiplied by 4 to 10 times depending on the country. Not all countries have been able to catch up and some are relatively lagging behind. Furthermore, such a quick increase has implications over governments’ ability to react. Sometimes they are not able to catch up with the demand, let alone under adverse financial circumstances (i.e. the Asian Financial crisis in the late 90s). Governments have opened doors for private resources to pour in - some institutions have been privatized, others are receiving private resources, but these measures do not seem enough.

For example, the Philippines is one of the slowest countries to increase the proportion of higher educated people. There, 80% of the enrolled people in higher education institutions are enrolled in private institutions. A majority of students who cannot afford private institutions are left out.

Recently, developments in finance have allowed the creation of different ways of long term financing and investment, mainly through securitization and the deepening of world financial markets. These improvements have brought back the original idea of Friedman (1955): to invest in the equity-like potential of individuals to generate income in the future. Human Capital Contracts (HCC) develop that idea. In HCC, an individual counts with its future earnings as a warranty and source of resources, which will cover an original investment.

Assume a student 'X' just finished high school and he does not have the means to keep studying. X has access to credit but it might be too expensive to take a loan from the bank, X is afraid that he will not be able to cover it or that it will become burdensome in the future. In that case, the idea of HCC is to allow X to finance his education in exchange of a percentage of his future income during an agreed period of time. X might be afraid that the final outcome does not cover the payments in a normal loan. In HCC the risk is carried by the investor. If, after graduation, X earns only USD200 per year, he will only have to pay back USD20 with a commitment of 10% of his income. On the other hand, if X earns USD20,000 in one year, he will be requested to pay USD2,000. The latter might make X scared of paying too much. Still, HCC can be structured to avoid such circumstances through caps and Human Capital Options. Investors can also ensure themselves with options or insurance to avoid too low payments, as long as they are available with a third party willing to take over that risk in exchange of a fee.

Then, one question arises: why would anyone risk so much if he/she cannot know the future income of students after graduation? In fact, by using information from college graduates with similar characteristics, we can make an educated guess of the average income the potential applicants to HCC will have in the future. The characteristics are the study field and other socio-demographic criteria. Thus, the percentage of income to commit in HCC can be derived from the estimation of the future income. Future payments will compensate investors for the risk taken in financing the applicants’ education.

Some might still think that HCC are too risky, but it is an average and very low income students are offset by high income ones or by other measures such as insurance or options. This kind of contracts already exists. MyRichUncle™ (www.myrichuncle.com) started operations in 2001. It was the first institution to invest in this kind of contracts. It has been followed by institutions in Germany, Chile (www.lumni.cl) and Colombia (www.lumnicolombia.com). In order to avoid creating a contract too burdensome for the applicants, these institutions have set the maximum amount a student can commit up to 15% of his/her income, during 10 to 15 years after graduation.

HCC will only be implemented after addressing the question of their viability. It means that we want to know if the current income generated by graduate students is enough to cover and to attract investors without becoming exaggeratedly burdensome for students. We need data in order to deal with this question. This is the reason why I wrote this short article. This research needs databases which illustrate graduates characteristics: i.e. income, household structure, working time per week, field of study or career, among other information.

If you are interested in HCC or if you know where this data is available for your country, please let me know. You can address your questions and suggestions to my personal email:This email address is being protected from spambots. You need JavaScript enabled to view it.